What To Do With an IRS Backup Withholding Notice

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If your business works with individuals who are not full-time employees, maybe freelancers or contractors, you'll need to make sure taxes are paid the right way. If not, there's a chance you could receive a notice from the IRS about backup withholding. When that happens, there are a few steps you'll want to take to rectify the situation.

Key Takeaways

  • A backup withholding notice is just one type of notice your business might receive from the IRS.
  • If your business works with nonemployee workers, like freelancers or independent contractors, there's a chance you could get this notice in the mail.
  • If that happens, you'll want. to send a copy of the notice to the worker and ask them to sign a new W-9 form.
  • You may need to withhold taxes from the individual's pay while you wait for the new W-9 form, or you may need to start backup withholding from the payments made to that person.

What Is Backup Withholding?

Backup withholding is income tax withholding required for workers who are not full-time, salaried, W-2 employees (like freelancers or independent contractors). You know that you don't have to withhold income taxes from payments your business makes to nonemployees, but you are required to have a W-9 form signed by each of these workers or contractors.

A W-9 form is like a W-4 form for employees and includes information on the person's name and address, and most importantly, their taxpayer ID number.

When a nonemployee's taxpayer ID number is missing or wrong, the IRS may send a backup withholding notice to the employer in order to seek tax payments. When that happens, there are a few steps you can take.

What To Do With a Backup Withholding Notice

A backup withholding notice, sometimes called a "B" notice, states that the nonemployee's taxpayer ID number is either missing or incorrect. When you receive the first IRS notice, you should follow these steps:

  1. Send a copy of the "B" notice to the individual and ask them to sign a new W-9 form.
  2. If the IRS says the taxpayer ID is missing, immediately start withholding taxes at the rate of 24% from that nonemployees pay, no later than 30 days after you receive the notice.
  3. If you receive a new W-9 form from the person, and you have an old W-9 form with that person's taxpayer ID, check to make sure that you have a new taxpayer ID. You can stop backup withholding if you receive a new W-9 form from the individual.
  4. If you cannot find the taxpayer, the taxpayer refuses to complete Form W-9, or the person doesn't respond, you must immediately start backup withholding (at the 24% tax rate) from the payments made to that person.

What If You Receive a Second Backup Withholding Notice?

The second "B" notice tells the individual taxpayer to contact the IRS or Social Security Administration to obtain a correct taxpayer ID number. You as the employer are not required to do anything except continue to withhold income tax from the taxpayer's payments until you receive a new W-9 form from the individual.

What Is a Backup Withholding 'C' Notice?

A "C" notice is a backup withholding notice from the IRS stating that the nonemployee has understated income and is subject to backup withholding. When you receive the first "C" notice, you should follow these steps:

  1. Immediately start withholding taxes at the rate of 24% from that nonemployee's pay, no later than 30 days after you receive the notice.
  2. Send or give a copy of the "C" notice to the individual.

If you receive a "B" notice or a "C" notice, you must continue withholding until you are informed by the IRS to stop withholding.

When in doubt, always start backup withholding on payment made to an individual and let the taxpayer sort out the taxpayer ID problem with the IRS.

Reporting and Paying Backup Withholding to the IRS

When you start backup withholding from a person's income, you're not done with the IRS. You must pay these withheld taxes to the IRS, report on the payments you have made, and include the information on backup withholding on the person's 1099-MISC. 

Making Backup Withholding Payments

Backup withholding payments are not made through the same process as for employee income. Make payments separately, using electronic funds transfer (EFT). 

  • If the total amount for all backup withholding payments is less than $2,500 for the year, you may make payments along with the annual report form (IRS Form 945). 
  • If the total is more than $2,500, use either the semi-weekly or the monthly schedule to make deposits.

You must report payments you collected for backup withholding on Form 945, Annual Return of Withheld Federal Income Tax. Form 945 is due by Jan. 31 of the year after the tax year ends.

Reporting Annual Backup Withholding Payments to Independent Contractors

You'll need to include the total backup withholding payments for each contract worker on their 1099 form for the tax year. Give it to the person and file it with the IRS by Jan. 31 of the year following the tax year. They'll need it to file their taxes.

Frequently Asked Questions (FAQs)

What does backup withholding mean?

Backup withholding is the tax that a business must ensure is paid to the IRS for nonemployee workers. If a nonemployee does not fill out a W-9 form or they fill it out wrong, such as using the wrong taxpayer ID number, a business will get a notice from the IRS and it should immediately begin backup withholding from the person's payments at a rate of 24%.

How do you know if you're subject to backup withholding?

If you're subject to backup withholding, the IRS will contact you, or if you're a nonemployee for a company, the company will likely contact you. You'll be subject to backup withholding if you don't pay taxes on the income you receive as a nonemployee. This could be due to an error on your W-9 form. If you underreport income, you may also be subject to backup withholding.

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